Elite Chinese Politics and Political Economy

My name is Victor Shih, currently an assistant professor of political science at Northwestern University specializing in Chinese politics. This blog shares my musing and discussions on Chinese politics and political economy with interested readers. You can contact me at vshih AT northwestern.edu, and my website, where I post my recent research is: http://faculty.wcas.northwestern.edu/~vsh853/

Monday, November 19, 2007

Great article from the WSJ on the new slate of macroeconomic measures: loan freeze. I think there will be non-compliance, especially among local financial institutions.

SHANGHAI -- Chinese authorities are slamming the brakes on bank lending, in their latest attempt to curb the runaway investment threatening to overheat what is soon to be the world's third-largest economy.

In recent weeks, regulators have quietly ordered China's commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals.

A China Banking Regulatory Commission official here confirmed that local and Chinese subsidiaries of foreign banks have been asked to ensure that loans at the end of the year don't exceed the total outstanding on Oct. 31. The official described the request as "guidance aimed at supporting the macro-control measures being implemented."

Over the past few years, Chinese authorities have repeatedly sought to rein in investment in sectors such as property development, where they deemed it was becoming excessive. But even in China a blanket edict to halt lending growth is unusual.

Curbing lending by raising interest rates, as China already has done four times this year, would be more in keeping with Beijing's increasingly market-oriented approach to business. But the lending freeze shows how the slowing U.S. economy may be complicating Chinese policy making. Lower interest rates in the U.S. give Beijing less room to push up rates without creating a ripple effect.

By raising rates further China could risk boosting the value of its currency, the yuan, too much for the comfort of its exporters, a critical part of the Chinese economy. A stronger yuan would make Chinese exports less competitive in world markets.

Bankers say they will honor the lending edict, partly because it comes with threats of financial penalties for noncompliance. "Which commercial bank would dare not obey this?" says Liu Haibin, chairman of the supervisory committee of Shanghai Pudong Development Bank Co.

A Bank of China Ltd. official in Suzhou said over the weekend his branch is pushing big corporate loans into next year. An official of the same bank in central Henan province said the new measure in effect extends existing lending controls on property developers and power producers across the board to all banking clients. The measure could pose a particular challenge for the Chinese units of foreign banks, which have less flexibility than their larger local peers.

How much lasting impact the measure has could depend on whether it is extended in some form in January, bankers say.

Even a temporary lending freeze, however, could cast a chill on important segments of the Chinese economy, including the stock market, whose steep run-up over the past year has given rise to fears of a speculative bubble. Though off their highs, Chinese share prices have nearly doubled since late 2006.

The lending freeze doesn't appear directly related to concerns about a stock bubble. Still, it could weaken the earnings of banks and other listed companies and leave less cash for investors to plow into stocks. In recent weeks, stocks have tumbled 15% or so from their record highs on concern China's central bank would lift interest rates or take other steps to cool the economy. China's benchmark one-year lending rate is currently 7.02%.

Less lending also could rein in China's resurgent housing market or hurt consumer confidence. Some companies operating in China, particularly smaller ones, may be hard put to find basic working capital to pay staff or buy materials at year end, bankers say.

"If loan growth were to stop, that would seriously disrupt investment plans and would introduce a high degree of uncertainty regarding financing," says Stephen Green, an economist at Standard Chartered Bank in Shanghai.

It has been three years since Premier Wen Jiabao pledged to deal with "severe" problems associated with rampant credit growth. But despite repeated rate increases, economic data still point to risks that haphazard investment could make the Chinese economy spin out of control and possibly lead to hyperinflation or a spate of bad loans.

Just last week, the government said fixed-asset investment in factories and property expanded nearly 27% in the first 10 months of 2007 from a year earlier, one of the highest rates in recent years.

Gross-domestic-product growth, at 11.5% in the first nine months of 2007, is on pace this year for its fastest rate since the blowout years of the early 1990s, when growth peaked at more than 14%. Soaring food prices and rising fuel charges are sowing concerns about consumer-price inflation -- which in October stood at a decade high of 6.5% -- and risking social discontent.

It isn't easy to predict whether a pause in bank lending so late in the year might dent China's economy. Several bankers said the fourth quarter is generally quiet for lending anyway, and that many banks have already met or even exceeded year-end lending targets. In late 2005 and 2006, regulatory officials backed up rate increases by jawboning bankers to slow lending in the fourth quarter, but bankers say the end result was a rebound in lending in the first quarter of the following year.

Individuals may be less affected than businesses because smaller loans may not raise eyebrows like big corporate working-capital loans. But at least one property agency in Shanghai is advising clients to delay mortgage applications until January.

Meanwhile, a China Construction Bank Corp. official in Shanghai said he is for now rejecting loans for everyone but established clients.

Instead of trying to target lending levels, economists say China could try to damp credit expansion by pushing up interest rates and letting the yuan appreciate against the U.S. dollar, since both adjustments would make borrowers and lenders think twice before committing to projects. U.S. officials, including Treasury Secretary Henry Paulson, regularly deliver such a message, saying a more market-oriented financial system is in Beijing's own interests.

But after its four interest-rate increases this year, the People's Bank of China appeared to question that idea after the Federal Reserve cut U.S. interest rates in September to offset turmoil in the subprime-mortgage market.

Beijing's concern about the stability of the yuan may be the reason, since higher interest rates tend to attract more depositors, an unwelcome prospect for Chinese policy makers keen to minimize enthusiasm for the yuan. A stronger yuan could hurt exporters by making some goods more expensive for buyers paying in dollars or euros.

Beijing may still raise interest rates. It had been tolerating a moderate strengthening of the yuan for much of this year, giving the currency about a 10% gain since a revaluation in mid-2005. But bankers say in recent weeks authorities have nudged large Chinese banks to buy dollars and sell yuan, trades that pushed the yuan down 0.2% last week in Shanghai trading.

The loan freeze may have a particularly disruptive effect on foreign banks with subsidiaries incorporated in China. Foreign bankers occupy just a corner of China's financial system, and they say they are eager to remain on good terms with regulators.

Foreign banks in the important Shanghai market -- including Britain's HSBC Holdings PLC and Standard Chartered PLC, New York-based Citigroup Inc. and Hong Kong's Bank of East Asia Ltd. -- controlled 6.2% of industry deposits at the end of September and more than 16% of loans outstanding, according to official figures.

Because foreign banks have fewer deposits than their more entrenched Chinese counterparts and regulators are already pushing them to keep outstanding loans at 75% of deposits, they have very little financial flexibility. Their earnings could also take a hit if they need to borrow in local money markets or sell loans to comply with the freeze.

Beijing has a long history of dictating policy to banks, which until recently were all state-owned institutions. Regulators have pushed banks to address bad loans held over from government-ordered "policy" lending in the 1990s. Since 2004, authorities have leaned on bankers to curtail lending to particular industries deemed to be squandering investment, including aluminum smelters and small property developers, to avoid another upsurge in nonperforming loans.

In April 2004, the China Banking Regulatory Commission offered "guidance" to banks that they slow new loan approvals. But it quickly backed off when economists complained that the government should treat banks like commercial enterprises, and instead authorities later lifted interest rates for the first time in nine years.

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Jason Leow in Beijing and Bai Lin and Ellen Zhu in Shanghai contributed to this article.